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The upcoming Consumer Price Index (CPI) report this Thursday may well prove to be the latest bearish indicator to send the markets into frenzy. Just days out from the Federal Reserve’s latest gargantuan interest rate hike, economists and financial operators are holding their breath that the upcoming inflation report doesn’t result in a brutal market crash.
Inflation has been at the heart of this year’s financial and economic turmoil. After all, the Fed’s forceful tightenings have basically been the beacon call of unruly 9% to 10% inflation this past year. As part of it’s long-mythologized “soft landing” — a sort of economic unicorn where inflation is eased via hawkish monetary policy without sending the country into recession — the Fed has pushed out rate hike after rate hike.
Indeed, the Fed’s tightening has been nigh-exclusively with the intention of lowering inflation. In that regard, this week’s CPI report will likely write the script for the central bank’s future monetary policy. In particular, should inflation come in better than expectations, the Fed may opt for a smaller rate hike in December — or even forgo raising rates all together. On the flipside, should inflation continue to rear its ugly head, any potential “dovish pivot” will end up dead in its tracks. The Fed would likely lock in additional hikes in the months to come.
The CPI Controls the Stock Market
In the short term, the CPI will inform immediate market decisions in perhaps significant ways. The stock market has responded sporadically to practically every monetary announcement this year. So, this time around will likely prove no different. Just last week, the S&P 500 dropped more than 2% after Fed Chair Jerome Powell announced the expected 75 basis-point rate hike. Even when markets are prepared for the news, traders still make panic decisions that yield significant consequences for equity markets.
Moreover, on Sept. 13, the S&P sank 2.7% after the August CPI came in just slightly hotter than expected. Though, the stock market hasn’t quite reacted uniformly to inflation news. On Oct. 13 for instance, after yet another disappointing CPI reading, the S&P actually bounced around all day before eventually rallying. It closed up by 2.6%.
Stubborn inflation means the Fed has all the more reason to continue raising rates, which means more expensive debt for many highly leveraged companies, which means weaker bottom lines and even worse stock market performance. This is why a disappointing CPI report can make the difference between a bullish or bearish stock market, or even a market crash.
With that in mind, what exactly will a good or bad CPI report look like?
October CPI Projections Mixed as Market Crash Rumors Swirl
Despite the Fed’s best efforts, projections for the upcoming CPI report are still largely up in the air. Last month showed an 8.2% year-over-year (YOY) increase in prices. Should inflation fall below that, it could be considered a success on those grounds alone. With that said, even just days away from the reading, CPI predictions are still all over the place.
The Cleveland Fed, for example, projects a month-over-month rise in prices of 0.76%, which would amount to the highest monthly reading since June. That would represent an annualized price level increase of nearly 10%. This is, predictably, not a strong sign for inflation. Should the Cleveland Fed prove accurate, expect the stock market to react with a potentially substantial selloff.
On the other hand, Econoday’s consensus estimate puts the October CPI at 8% for the year. While only a modest improvement, this would be considered a win for both the Fed and the stock market.
Likewise, the New York Fed’s “underlying” inflation calculation has made a notable downward turn. The New York branch of the central bank operates its own inflation calculation that tends to lag behind core CPI by a few months. For much of this year, the gap between core CPI and the NY Fed’s underlying inflation reading has widened substantially, leading some economists to predict inflation will likely fall substantially in coming months and match up with the underlying reading.
Finally, the University of Michigan’s Survey of Consumers shows a notable decline in inflation expectations over the past few months. Indeed, from 5.4 in March and April — its highest level in nearly four decades — the index now has a reading of 4.7, showing a notable decline in inflation expectations. While this doesn’t offer a clear CPI projection, it certainly reflects the fact that consumers seem to believe prices are beginning to fall. That may bear relevance on Thursday.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.